Auditor Liability in Market Meltdown?

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It should come as no shock to anyone that lots of fingers are being pointed related to Wall Street’s meltdown, and specifically related to the banking industry. And auditors are likely to find themselves the targets of lawsuits. Auditor malpractice is often hard to prove, but in this case, I think there will be several victories against the auditors.

Compliance Week discusses the possibility of liability for the auditors, but of course, the big audit firms are saying “move along, nothing to see here.” They’re counting on “blown audits” to not be a point of contention, but I can’t see how they could possibly be right.

Large companies like AIG and Lehman didn’t implode overnight, and there are almost certainly some issues that came up during audits that may have pointed to problems… yet the auditors weren’t telling anyone. (Why should they? After all, their number one goal isn’t protection of investors in public companies. The goal is protection of client relationships to ensure the annual audit fees come rolling in.)

Patrick Daugherty, a partner with law firm Foley & Lardner, told Compliance Week the current meltdown is different from frauds like Enron. I disagree. There almost certainly is an element of fraud in this situation, it’s just that at Enron the fraud was concentrated at one company, and currently it’s spread among many firms. He says, “No one is saying financial management is deliberately misleading investors, or that a particular auditor or audit firm was in cahoots with management to mislead the market.”

Really? No one? Because phony valuations of assets and failure to report the true financial conditions related to mortgage-related assets sounds like “cahoots” to me! Daugherty opines that the auditing firms will be questioned about valuations, but that they’ll win. Damien Blenkinsopp, associate director for Kennedy Information and a consultant to the Big 4, also told Compliance Week that the auditing firms think they’ll win.

Something tells me that this is more about giving the public the perception that they’re right by saying they think they’re right. Keep telling them often enough that the auditors have no blame, and eventually people may believe it.

Gaylen Hansen, a partner with the Colorado auditing firm Erhardt, Keefe, Steiner & Hottman, and a member of the Public Company Accounting Oversight Board’s Standing Advisory Group seems to agree with me. She told Compliance Week that people may have been expecting earlier warnings about problems at the banks and investment firms.

Pricewaterhouse Coopers (PwC) has already settled one audit malpractice claim related to AIG, paying $97.5 million to three Ohio pension funds. But they’re not alone. All of the Big 4 had their stamps of approval on audits of now defunct companies, and they shouldn’t be too cocky about their chances of avoiding big malpractice claims.

The profession of auditing is likely going to change, and soon. Whether the big auditing firms change by choice, or are forced to change, is really up to them. I’ll be watching from the sidelines.